Educational Articles

Maize Malaise

Adam James Platt
| September 06, 2012

This summer has seen drought conditions prevail over the vast majority of the continental United States, hitting hardest in the Midwest “corn belt”. The drought peaked during the corn pollination stage, which is critical to crop yields, and USDA projections predict an unusually steep decline in production this year. Corn is by far America’s largest crop by value, and with this year’s crop ravaged by the worst U.S. drought in decades, its futures have skyrocketed since June.

The last decade has seen a major boost for corn farming, as prices rose from around $2 to $3 a bushel in 2002, to over $8 currently. Much of the long-term rise in demand has come from the increasing use of corn in the production of ethanol, but some has also come from rising global demand for agricultural products. Emerging markets in particular have developed rising incomes, populations, and appetites for more varied diets than in the past. Fears of a corn shortage due to this summer’s drought and the resulting poor crop yields have led to the latest spike, creating both winners and losers.

One loser from rising grain prices has been Tyson Foods (TSN), the world’s largest processor of meat products, which is suffering from the skyrocketing cost of animal feed. Tyson shares took a sharp decline this summer, and are now more than 25% below their 2012 high. The company recently cautioned that rising grain costs due to the drought are likely to put downward pressure on 2013 results. Meanwhile Archer Daniels Midland (ADM), a major agricultural processing company, has been hit hard by declining crop yields. Fiscal 2012 earnings (year ended June 30, 2012) came in significantly lower than expected, marking a large year over year decline, and 2013 is projected to be only slightly better.

On the other hand, the drought has had a positive effect on seed companies, which already had global trends on their side before the crisis. The global seed market is expected to grow dramatically over the next few years with an increasing presence of genetically engineered seeds. Du Pont (DD - Free Du Pont Stock Report) runs a large agricultural business, headed by its Pioneer segment. Its drought-resistant seed business, launched last year, may get an early boost from farmers looking for ways to beat future droughts. Monsanto Company (MON), a global seeds and genomics giant, plans a full-scale U.S. launch of its first drought-tolerant corn product in 2013. Since 2007, the company has collaborated on joint research and development with BASF to focus on developing drought-resistant crops, and the results are coming to market with apt timing. The company intends to focus its marketing efforts in the western great plains states, a stretch extending from South Dakota in the north to Texas in the south, due to the region’s drier conditions and lower yields per acre than states in the heart of the corn belt, such as Iowa and Illinois. However, it is no sure thing that drought-resistant seeds will be economical for all farmers, as the yield increase for many is under 10%, while the seeds cost planters a high premium. Whether the marginal benefit will exceed the marginal cost increase will depend largely on the price of corn in the future and whether drought-like conditions become more common than in the past.

Fertilizer companies will likely benefit as well, as high crop prices have sent farmers scrambling to increase their supply going forward. Meanwhile, worldwide population growth and per-capita income in developing countries have provided a backdrop of long-term growth in demand for crops. For example, Agrium (AGU), a leading producer of nitrogen fertilizer and potash, has seen its share price rise about ten-fold over the past decade, as earnings have gone from $0.79 in 2002 to a record $9.52 in 2011. Over that period, the balance sheet improved dramatically as well, with working capital now outweighing total debt by a hefty margin and long-term debt accounting for less than 25% of capital. Agrium boasts an impressive return on total capital, which last year topped 18%. Another large fertilizer company, Potash Corp. (POT), has seen a similar boom. The company’s return on total capital topped 27% last year, on record earnings. Going forward, the company is looking to increase sales in developing markets, where crop yields still lag far behind those in more developed countries.

Overall, food processing companies have suffered from the drought, while seed and fertilizer producers, which have been booming for years, just became even stronger.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.